The Underground Economy and Tax Evasion in Pakistan. A Fresh Assessment

This paper assesses the size of the underground ~conomy and tax evasion in Pakistan for the period 1973-96. Using monetary approach, the results confirm the existence of large underground economy and higher tax evasion over the period under analysis. The overall underground economy has remarkably increased from 20 percent of GDP in 1973 to 51 percent of GDP in 1996. The evidence also suggests that the rate of growth in th~ underground economy has been higher than the rate of growth of the formal economy. The estimates of various component~ of the black economy indicate that incomes fr01TIunderground activities in the foreign trade tax sector have been higher than the domestic tax and non-tax sectors. Furthermore, total tax evasion has peaked from Rs 1.5 billion in 1973 to Rs 152 billion in 1996. Finally, the paper concludes that the loss of public revenues and the increasing demand on public services by underground activities are important contributing factors for the mounting fiscal deficit in Pakistan.